Vertical Software 2.0
Expansion opportunities in vertical software
Since the inception of Point Nine, we, at Point Nine, have been investing in vertical software (ie. in companies focusing on one industry) like Clio, Jobber, NexHealth, Amenitiz, and many others. Since 2016, we’ve been increasingly interested in B2B marketplaces, partnering with companies such as Container xChange, cargo.one, or Metalshub. More recently, we’ve worked with more and more “Vertical AI” or “AI-first” vertical software companies. These leverage data and machine learning at their core to build products that wouldn’t have been possible to build before (companies like Intenseye or Upciti).
Over the past few quarters, we’ve observed an interesting convergence of these categories. We believe that this convergence opens a lot of expansion opportunities in Vertical Software, which we could call “Vertical Software 2.0”. It also provides a good answer to those who argue that we’ve reached a stage of relatively advanced maturity in software, ie. that there aren’t that many opportunities left in software anymore.
We’ll try to explain why below.
1. B2B marketplaces are Vertical Software businesses
Reflecting on some B2B marketplaces’ monetization challenges, one of the ongoing topics we discussed last year was whether B2B marketplaces can work well enough to create truly large companies. We started investing in B2B marketplaces hoping that they could be the holy grail of marketplaces, because of the high frequency of usage and the large transaction values (see Julia’s post from 2020 here). We expected commission rates to be lower than in B2C because of the size of the transaction values but the extent to which they turned out to be lower has, in some cases, surprised us. In a few instances, B2B buyers/sellers proved to be reluctant to even pay any commission. We often saw B2B buyers/sellers showing higher price sensitivity than consumers, valuing convenience less than consumers, and, arguing that most transactions were coming from their existing customer base.
This highlighted the need for a better business model.
After a few iterations, we concluded that B2B marketplaces create value and, therefore, could monetize through a combination of:
- A typical marketplace business model for what’s a typical marketplace value proposition: creating new matches between buyers and sellers. It can sometimes be as little as 10–20% of transactions.
- A SaaS business model for what’s a typical software value proposition: automating workflows and processes (including transactions) between buyers and sellers who already know one another. It can sometimes be up to 80–90% of transactions. The ROI of using the software is usually linked to cost optimization enabled by software-enabled workflow automation(s). It often looks like procurement software on the buy side, and, sales management software on the sell side.
While this view might look like a business model twist, it also brings a new way to look at B2B marketplaces first and foremost like vertical software businesses, monetized with multiple revenue streams (including subscriptions) and defensible through network effects.
We’ve also seen the emergence of additional revenue streams for B2B marketplaces such as:
- A fintech business model for the financial services offered on top of the transaction flow (eg. payment, lending),
- A logistic business model for the logistic services provided to ship goods from the seller to the buyer (eg. a take rate on discounted logistic services like shipping or warehousing),
- An advertising component to monetize the high intent / highly specialized traffic of the marketplace with very customized, highly converting ads, and/or,
- A data business with businesses monetizing the transaction data that they collect in their industry.
The table below summarizes the above:
Now, let’s go back to our initial question of where we’re at in the tech/software innovation cycle. Still today, trillions of dollars of B2B trade/payments are offline and waiting to be digitized. As Matt Brown at Matrix rightfully writes “B2B payments aren’t payments, they’re workflows”. Workflows that often differ from one industry to another. We believe these trades represent as many opportunities to build B2B marketplaces or workflow-based vertical software businesses monetized as described above.
2. Expansion Opportunities in Vertical Software
Taking the perspective of traditional vertical software businesses (let’s call them Vertical SaaS 1.0 here), one concern that comes up is that the size of the opportunity (ie. the TAM) these businesses go after is too small. This sometimes led VCs to conclude that vertical markets are too small to allow for venture-sized returns (or fast enough growth).
The first learning is that vertical software businesses often have much higher market share and lower costs of acquisition at scale than their horizontal counterparts. This is partly explained by lower competition intensity and stronger industry word-of-mouth.
Other ways to increase the TAM include:
1) Expanding the product scope to increase the Average Revenue Per Account (ARPA),
2) Broadening the target market by going after different companies, and/or,
3) Going after different personas in the same organization.
In certain cases, expanding geographically isn’t possible, and therefore the company will try to go upmarket (go after larger clients) in the same country. In others, companies can’t go upmarket and will decide to expand internationally. There are multiple ways to enlarge the target market.
If the above isn’t enough to create a large enough market opportunity, we believe that the emergence of additional business models in software provides as many additional answers to the “size of the opportunity/TAM” question.
The first additional answer is to layer financial services on top of the software. Base10 wrote a post in 2019, called “Don’t Be Fooled By TAM: Payments Unlock Giant Opportunities In Deceptively Small Markets”. They argue that payments but also broader banking services (credits, payment cards) could allow vertical software businesses to extract a percentage of the total industry spent. This is also made increasingly possible by the availability of fintech building blocks, PSPs like Stripe, B2B payment/credits providers like Hokodo, or banking-as-a-service services like Swan or Solaris Bank.
Another additional answer is that vertical software solutions that reach a certain scale can start building distribution/procurement value propositions for their client base. For Amenitiz, our portfolio company that’s building an all-in-one software for small independent hotels, this could mean plugging their client base of small hotels as inventory to distribution partners like Global Distribution Systems to increase their clients’ bookings. It could also mean becoming a Group Purchase Organization (or GPOs) to offer better rates to their client base. This is how what started as back-office management software (ie. Property Management Software) is becoming a source of additional revenues and decreased costs. In the first part, we explained that B2B marketplaces were vertical software businesses, the above is an indication of the convergence from the other side (from Vertical Software to B2B Marketplace).
Another additional answer is to leverage the highly retained traffic/eyeballs on the vertical software solution to build advertising value propositions. Doctolib just launched an advertising business model where pharma companies can buy advertising campaigns on the software, just like they’d do on Google or offline but with a highly specialized audience. Doximity in the US is selling advertising campaigns to pharmaceutical companies.
Last but not least, the broader availability of well-performing AI building blocks (sometimes relying on LLMs) opens the possibilities for automating many industry-specific jobs, performed by humans up until now. The aim is to automate jobs more than processes, thus allowing vertical software solutions to capture (and shrink) HR budgets rather than software budgets.
Our portfolio company Intenseye leverages computer vision to enable health and safety professionals to constantly monitor that safety rules are followed in manufacturing facilities. They can then leverage Intenseye’s robust analytics to create better workflows for their teams and ultimately increase the level of safety. Also leveraging computer vision, Sereact goes further completely replacing humans, who used to pick and place items in boxes in logistics warehouses, with robots who can detect items with no/little pretraining. Both businesses use this “automation of work” value proposition as a wedge to build a broader software platform. Our portfolio company cargo.one, a B2B marketplace for air cargo, uses LLMs to prefill booking requests on their marketplace, extracting data from emails automatically and freeing freight forwarders from time-consuming tasks.
Vertical Software solutions are ideally positioned to capture these “automation of work” opportunities because they have software-building expertise, existing distribution channels, and a data advantage.
Conclusion
Some believe that we’ve reached a stage of advanced maturity in software. If we sum up the above, we believe that we might be just “scratching the surface” when it comes to value capture by vertical software solutions. We call it Vertical Software 2.0, which the graph below illustrates:
At the end of the day, the opportunity in vertical software is about using every technological building block available to digitize markets, starting from what makes the most sense for the industry (ie. enable the fastest adoption). Sometimes it’s workflow software, sometimes it’s fintech, sometimes it’s a marketplace, sometimes it’s automation.
We start 2024 as convinced as we’ve ever been that being in the software business is… a great idea!
